Lecture 2: Basic Definitions

• GDP
• Inflation Rate
• Unemployment Rate
• Trade and Budget Deficits

 Gross Domestic Product

• First thing we look at (its rate of growth)

• Aggregate output: Not easy!

– Sum of apples and oranges
– Double-counting
• Example
 A Simple Economy

• Steel Company
– Revenue from sales $100

– Expenses (wages) 80

– Profit 20

• Car Company
– Revenue from sales $210
– Expenses
• Wages $70
• Steel purchases 100
– Profit 40
• What is this economy’s GDP?

 Calculating GDP

• Method 1: GDP is the value of the final

goods and services produced by the
economy during a given period
• Method 2: GDP is the sum of valued added
produced….
• Method 3: GDP is the sum of incomes in the
economy...
 Nominal vs Real GDP

• Nominal GDP: sum of final goods produced

times their current price
– Growth due to quantity (production)
– Growth due to prices
• Real GDP: … times their base year price

• Example (next trp.)

• GDP Growth: (Y(t)-Y(t-1))/Y(t-1)
 Nominal vs Real GDP

Year 0

Q P Value
Potatoes 100,000 $1 100,000
Cars 10 $10,000 100,000
Nominal GDP 200,000

Year 1
Q P Value
Potatoes 100,000 $1.2 120,000
Cars 11 $10,000 110,000
Nominal GDP 230,000
 The Inflation Rate

• More than one…. (P(t)-P(t-1))/P(t-1)

• GDP deflator and CPI

• GDP deflator = Nominal GDP / GDP
– P0 = 1
– P1 = 230,000/210,000 = 1.1 (approx.)
• NGDP growth = GDPg + Inflation (defl)

• 15 5 10
• Why do we care?
 The Unemployment Rate

• Labor force (L) = Empl. (N) + Unemployed (U)

• Unemployment Rate (u) = U/L

• Willing to work? Looking for work? L < Pop.

– Not in the labor force

– Discouraged workers (recessions)
• High unemployment often comes hand on hand
with low participation rate :
• L/Pop of working age
• U.S. (u = 4%, pr = 80% ) France (u=13%, pr = 65%)

• Why do we care? Too high and…. too low??

 Deficits

• Expenditure > Income

• Trade Deficit :
– Imports > Exports
– U.S. today (FED, Treasury, Japan)
• Budget deficit
– Gov. Expenditure > Gov. Revenue
• Why do we care? Smoothing; Argentina…
the US
First Model: The Goods Market

Production Income

Demand